Equity & options
Also called incentive stock options, non-qualified stock options, ISOs and NSOs
ISOs are tax-advantaged stock options available only to employees, potentially taxed at capital gains rates if holding requirements are met; NSOs can be granted to anyone and are taxed as ordinary income on the spread at exercise.
Incentive stock options can only go to employees. Non-qualified stock options can go to employees, advisers, contractors and board members, which is why adviser grants are almost always NSOs.
On exercise, an NSO holder owes ordinary income tax on the spread between strike and fair market value, withheld at the time. An ISO holder owes nothing in regular income tax at exercise, though the spread counts toward alternative minimum tax.
If an ISO holder holds the shares more than two years from grant and one year from exercise, the entire gain is taxed at long-term capital gains rates. Miss either window and the ISO is treated as an NSO.
ISOs carry a $100,000 limit on the value of options first becoming exercisable in any calendar year, measured at grant-date value. Anything above that is treated as an NSO.
ISO status also ends 90 days after employment ends. Leavers who cannot fund an exercise within that window see their ISOs convert to NSOs, which is a common and unpleasant surprise. Some companies now offer extended exercise windows, accepting the conversion in exchange for fairer treatment of leavers.
No. ISOs are restricted to employees. Advisers, contractors and non-employee directors receive NSOs.
Only $100,000 of options, measured at grant-date value, may first become exercisable in a calendar year with ISO treatment. The excess is treated as NSOs.
ISO status expires 90 days after employment ends. Options exercised after that are treated as NSOs, which is why extended exercise windows have become a live topic.
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